Security token

Security token is a type of digital asset that represents or derives its value from some other, external asset and is issued on top of third-party blockchain network. Security tokens can both represent real-life material assets like square meters of real estate or grams of gold and non-material assets like, for example, companies’ shares. The process of generating security tokens is called a security token offering. Security token offering (STO) is a type of fundraising that is performed with a company offering tokenized securities. The defining feature of security token offerings is in its definition. When ICOs are conducted with cryptocoins and IPOs with securities, STO is a combination of both.

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Similarly to the classic securities, security tokens are mostly used for a funding gathering. However, security tokens are quite different from the classic securities due to the number of reasons:

Security tokens are easier to develop and distribute.

Security tokens are faster than classic securities and can be transferred, sold and exchanged at any time of the day if necessary.

Security tokens require significantly less third-party entities like repositories, exchanges and so on due to the blockchain-based infrastructure.

The advantages listed above make tokenized assets one of the most convenient ways for small companies to gather initial funding. Due to this fact, the question of what is a security token becomes more relevant as more and more companies decide to perform a security token offering instead of IPO or crowdfunding.

Security token issuance is performed by a number of security token platforms, some of which are:

However, security token services can be provided by the platforms that don’t specialize exclusively on the development of security tokens. Ethereum, Cardano and other blockchain projects also provide security tokens development.

Utility token is a digital asset that is used as a way to gain access to the products of its issuer or being useful by itself due to some of its properties. Utility token does not represent any other asset and does not provide its user with a right of ownership over something else than itself. As a result, Utility token vs Security token offers more straightforward value generation mechanism. Security token needs to derive its value from either its code or its backing assets when utility token is only valued by the functions it represents. The way of evaluating the price of these types of tokens is the defining difference between them.

Sometimes, experts compare utility tokens to gift cards, while security tokens are often described as something similar to investment contracts. An investment contract is described as a financial mechanism that requires a person to invest his or her money in a common enterprise due to the expectation of profits solely from the efforts of a third party. Security tokens and utility tokens both have their respective features and are used for different purposes and by using different technologies so the user of such assets should research the nature of the tokens before investing in or purchasing them.

Multiple sources mentioned that a digital asset is considered to be a security token if it fulfils the criteria of the Howey test. The Howey test is a way to establish if a particular arrangement is an investment contract. The test was developed as a result of the Securities and Exchange Commission v. W. J. Howey Co. case. The Howey test is defined differently in various sources, but generally, it declares an arrangement to be an investment contract if it fulfils 3 criteria as following:

It requires a money investment

Gathered funding goes to a single enterprise

Investor expects to gain income from the work of the third party

However, despite security tokens are always fulfilling all the three criteria, this definition is not the best way to determine if a token is, in fact, a security token due to the following reasons.

Utility tokens that don’t provide any ownership rights and are valued solely for their functions are very often fulfilling all the three criteria of the Howey test. Speculative prices and a limited number of issued tokens makes them suitable to use as an investment tool.

Some digital assets that also corresponding to all three criteria are not tokens, but coins. Tokens differ from coins by the fact of existence in their own blockchain networks. Tokens are issued on top of third-party blockchain (for example, Ethereum or EOS) while coins are powered by their own blockchain (Bitcoin, Monero, Litecoin).

Governmental regulations consider almost every token to be an investment because most cryptocurrencies can be defined this way by the Howey test. However, utility tokens, coins and security tokens are very different assets.